Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 28 February 2016

When to be optimistic on growth

I’m afraid I did not respond to requests to talk directly about the debate over Gerald Friedman’s numbers. I think I can only cope with that kind of thing one country at a time, and there were better people on the case. But I suspect a key to seeing your way through the wider debate is to know when to be optimistic about economic growth, and when not to be.

Martin Sandbu, channeling Narayana Kocherlakota, is quite right that we should not discount the possibility that economic growth could be unusually strong over the next decade or two. There is a significant chance that some of the slowdown that has appeared to have occurred to trend growth since the Great Recession might be reversible, partly because many hysteresis effects are also reversible. Inflation may not respond positively to strong growth as it has done in the past.

That possibility is high enough that it should have a big influence on monetary policy, for reasons I and others have outlined many times. The cost of needlessly throwing away potential resources is much higher than the cost of small overshoots of an inflation target. For that and other reasons the Fed’s decision to raise rates - and the MPC's decision not to cut them - was a mistake, as is continuing austerity.

Does that mean we should hard wire this optimistic view into budget projections? Essentially no, because budget projections should be based on your central guess of what is going to happen rather than any best case scenario. Almost every politician thinks they have the magic ingredient that will lead to strong growth. There is nothing wrong in that, but they should hope for the best and plan for the ordinary.

Doing this imposes a discipline on the electoral process that is essential to stop some politicians pulling the wool over voters eyes. If a politician or party wants to go with optimistic numbers, then the debate should be about how reasonable those numbers are, so voters can see what is going on. A world where these things are not debated is a world where everyone promises the moon and no one is any the wiser.

Where the discussion can get confused is if we put these two things together, and note also that fiscal stimulus involving additional investment would be good for the world right now. But that should and is argued for without pretending that it can all be paid for with the taxes that will come rolling in as it happens. There is a rock solid case for paying for extra investment - investment in its widest sense including human capital - by borrowing, because future generations benefit from that investment. When real interest rates are as low as they currently are, you have to be ignorant, duplicitous or slightly mad to say otherwise.



9 comments:

  1. Or, you should account for optimism when the probability is not too low, but you should not count on that optimism when the probability is not very high.

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  2. Seemed a good one to keep out of - lots of sound and fury signifying nothing

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  3. "Inflation may not respond positively to strong growth as it has done in the past."

    Isn't this very important? It requires some reasoning on why it is so.
    Unedrutilized production capacity is one f the things that allowes for inflation to be delayed.
    Another important one is lack of the Bretton-Woods and international gold standard. this is possitive thing, not a negative ones.
    Since there is no more B-W system in place, those countries that import using their own money can enjoy importing without causing inflation. Those "former" empires that can have benefit of using their own money for imports also enjoy printing money without causing inflation (except asset inflation).
    Those "former" empires like US, UK, Japan and British Commonwealth states do not destroy their own money when importing as others countries have to do. This money later returns back to importing country.
    This way, supply for imports is the world supply and there is no preassure on domestic producers to raise their prices due to strong demand. If demand for products is higher then domestic capacity, that demand will be imported using the same money to pay for imports. There is no Fx charge for paying for imports nor lack of money since that money stays in the system, domestic system to be loaned and pay for more imports.

    Former empires do not have inflation preassure when demand for product goes up. It will be imported instead of produced domestically.

    But there is then question of multipliers of stimulating the economy, how to prevent stimulus to be used for imports? Services like Healthcare, infrastructure and education can hardly be imported. It is mostly domesticly provided.

    Help for poor can be imported, this multiplier might not be very big but the hep on its own to your own population is an argument on its own, it is not important as stimulus to the economy.

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    Replies
    1. "this multiplier might not be very big"

      Let's expose the assumptions those types of statements are based upon:

      1. There is a fixed amount of money available.

      2. If the government spends from this fixed pot of money, it automagically crowds out an alternative activity with a multiplier of one.

      3. That you can ignore the effect on the distribution of savings.

      All of those beliefs are rubbish.

      Delete
  4. "But that should and is argued for without pretending that it can all be paid for with the taxes that will come rolling in as it happens. There is a rock solid case for paying for extra investment - investment in its widest sense including human capital - by borrowing, because future generations benefit from that investment. "

    The problem is you don't really have control over that.

    People keep conflating the total tax take with the distribution of the tax take. The two are largely separate and certainly should be considered separately.

    If government spends £100 then the recipient receives that money and pays some tax - in return for something or other. The recipient then spends again with somebody else, who receives the money less some tax - in return for something or other.

    That process then continues at a pace until the money is entirely taxed away. This is the case for *any positive tax rate*.

    It's a simple arithmetic progression.

    So the question actually is why is there a deficit at all? And that is because the money never gets spent entirely to destruction within the budget period - due to people saving rather than spending.

    The act of people saving *causes* borrowing on the other side of the accounting ledger (that's why you are in 'credit' at a bank - despite credit being the accounting term for a liability. The bank is 'borrowing' from you when you force your financial assets on them).

    So the deficit is entirely caused by the change in the private sector financial saving requirement, less the change in the private sector borrowing requirement. The government isn't borrowing. The private sector is saving and wants safe assets.

    You can't really change the total tax take very much by adjusting rates because it feeds back into the spending and borrowing decisions. All you can really do is affect the distribution of the tax take amongst the entities in the economy.

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    1. But as any fule kno, the bank doesn't just put my savings in the safe. Almost all of it is loaned out and spent.
      Anyway, like most people, I owe the bank far more than I have saved, so that extra money must also be generating taxes. So where does this deficit come from?

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    2. "Anyway, like most people, I owe the bank far more than I have saved, so that extra money must also be generating taxes. So where does this deficit come from?"

      Mostly corporate saving ATM.

      http://www.3spoken.co.uk/2016/01/uk-sectoral-balances-q3-2015.html

      "The Household sector continues to net borrow and the corporate sector continues to net save. The RoW is now saving less in Sterling per quarter than they were earlier in 2015."

      "But as any fule kno, the bank doesn't just put my savings in the safe. Almost all of it is loaned out and spent."

      http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspx

      http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf
      Money creation in practice differs from some popular misconceptions — banks do not act simply
      as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’
      central bank money to create new loans and deposits.

      The reality of how money is created today differs from the
      description found in some economics textbooks:
      • Rather than banks receiving deposits when households
      save and then lending them out, bank lending creates
      deposits.
      • In normal times, the central bank does not fix the amount
      of money in circulation, nor is central bank money
      ‘multiplied up’ into more loans and deposits.
      Although commercial banks create money through lending,
      they cannot do so freely without limit. Banks are limited in
      how much they can lend if they are to remain profitable in a
      competitive banking system. Prudential regulation also acts
      as a constraint on banks’ activities in order to maintain the
      resilience of the financial system. And the households and
      companies who receive the money created by new lending
      may take actions that affect the stock of money — they
      could quickly ‘destroy’ money by using it to repay their
      existing debt, for instance.

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  5. Yes, with interest rates so low, it would be rational for world governments to borrow money to finance infrastructure improvements. But I don't think they will do it, because politicians, pundits and the public remain freaked out by the size of their countries' national debts. I know you agree that we could and should be financing these necessary and stimulative investments by financing our budget deficits by central banks creating more money and simply transferring it to their national governments. This, in turn, is never going to happen until more high-profile economists(besides you) start explaining how this could work, and why it need not be inflationary. Until this discussion is widespread, we will continue to muddle along at best. Thanks for your efforts.

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    Replies
    1. In the UK we are investing in some very large-scale infrastructure improvements: e.g. HS2 will get people to and from the centres of Manchester and London a bit quicker than previously.
      Hooray!

      Delete

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